Institutions flash the cash in search of merger prospects

Institutional investors are entering the new year with large amounts of cash to pour into booming stock markets and expect to see high numbers of company takeovers, according to Merrill Lynch.

"We have a high level of liquidity," equity strategist Charles Cara said in a report. "That points to a continued good environment for mergers and acquisitions," though it was unclear if 2007 could top the record year of 2006.

The December poll of 210 fund managers across the world showed a net 53% of respondents expected the world economy to weaken next year but few believe that a recession is likely.

"It's all about Goldilocks and very little about the three bears," said David Bowers, a consultant to the investment bank. Like Goldilocks's porridge the economy would neither be "too hot" nor "too cold", with a return to a long-term trend of solid growth. "This is a growth slowdown, not a pullback."

Fund managers expect companies to continue the recent high-profile merger trend. "I think it will just carry on," said Karen Olney, head of Merrill Lynch's European equity strategy. Firms would mainly merge to cut costs and thereby generate growth. "All of the growth this year came from cost cutting." Merrill Lynch estimates that €420bn (£280bn) of funds were available to invest in European equities in 2005 and more in 2006.

Europe remains the first choice for investors, with 35% ranking the eurozone as the most favourable region in which to invest. Global emerging markets come second with 21%.

"In our view, European equities remain relatively cheap versus bonds, versus other regions and in historical terms on an implied growth basis," Ms Olney said. The eurozone economy continues to grow and its recovery is likely to continue, boosted by investment and consumer spending.

One cloud on the horizon was a concern among investors about rising long-term bond yields and thus borrowing costs. The percentage of fund managers saying they expected yield curves to become steeper over the next 12 months rose to 62% in December from 51% in the past two months. A surprise in the survey was that investors do not have the enthusiastic attitude towards risk-taking that might be expected with the Vix, the global risk-taking benchmark, at a 10-year low, Merrill Lynch said.

The poll showed investors were comfortable with the strength of corporate balance sheets, with 58% of fund managers believing companies could take on more debt. They were split on how the capital should be spent, with 44% of investors preferring companies to return more cash to shareholders, while 41% were keen for firms to invest more in their businesses.

Backstory

Global M&A values hit an all-time high in 2006 of $3.6 trillion - up 30% from 2005 - according to Thomson Financial. It was also a record year in Europe, with M&A worth $1.3 trillion. Goldman Sachs is still top globally, advising on $1 trillion of deals, with Morgan Stanley top in Europe. In equity capital, Goldman Sachs also came first. Initial public offerings hit an all-time high of $98bn in Europe. but China alone raised $94bn in IPOs.